Common Audit Triggers
Audits in Canada are typically assigned randomly. There are, however, some reasons as to why some taxpayers are audited more often that others.
Here are some of the most common factors which may increase the chance of being audited by the CRA, from most common to least:
Screwing around with Trust Funds
Sorry to be so blunt, but there is nothing that raises the ire of the Canada Revenue Agency (CRA) more than finding out, or suspecting that you have been less than honest with Trust Funds – the money taken from employees or customers and held in trust for the CRA.
In these instances, the CRA comes to audit fast, and leave no stone unturned.
The addition of self-employment income, along with or instead of T4 income is an area of significant concern for the CRA.
Earning T4 income, means is likely that the sufficient amounts of tax, CPP and EI have been withheld and remitted to the CRA on your behalf and on behalf of your employer, making it low-risk.
Self-employed individuals, on the other hand, do not, in most cases, have taxes withheld at source, making it more under the scope of the CRA.
The Industry you operate in
This is a two-fold flag because not only are some sectors audited more than others – dentists, real estate agents, restaurants, construction companies, and corner stores that take cash, for example, but the CRA also uses the industry that all businesses / taxpayers operate in, and compares the numbers reported to those of the others in your industry.
If you stand out for one reason or another, expect to be asked why, in the form of an audit.
Additionally, in around November of each year, the CRA computers match and compare many pieces of taxpayer information, looking for slips which were not declared, or for outliers.
3rd Party audits
Often times taxpayers are audited simply because a related party is being audited. Sometimes this means that family members or shareholders of a closely-held corporation are audited in the course of the audit of the corporation. Other times various corporations in a supply chain may be audited because of the audit of one of them. Sometimes contractors are audited because of a payroll audit at the corporate level.
There is nothing that can be done to minimize this risk factor. Unfortunately, the more businesses and taxpayers that a particular taxpayer is involved with, the greater likelihood of a CRA audit.
We represented a construction company which had immaculate books and records, yet were under audit by the CRA for almost a year. It made no sense, because every single item requested by the auditor matched and was reported correctly.
It finally came to light that a customer of this company from 8-years-ago had tried to commit fraud and claim a receipt for services which were never performed by this company (they had changed the date and written “CASH” across the invoice).
After proving the invoice was fraudulent, the audit suddenly ceased and the taxpayer who changed the invoice was charged with fraud.
You just never know!
Informant Leads Line Tips
The Informant Leads Line / or Tips line or Snitch line, has provided way more tax and audit leads that the CRA could have ever imagined – and still does.
In light of the fact that tips relating to offshore tax evasion may yield a reward for the informant, it may never end.
Moral of the story: taxpayers who are cheating the system should not count on staying under CRA’s radar forever. They should also be careful as to who has incriminating evidence which could be reported to the CRA.
Common leads come from; ex-spouses, former employees, and neighbours. So the next time you piss someone off, you might want to make sure they don’t reported you to the CRA.
Living Beyond your means – Net Worth Assessments
Taxpayers who live in a $4 million dollar house, and who report income of $1/year, can expect to have caught the attention of the CRA. The same goes for taxpayers who have debt to the CRA and are unable to pay, yet post publicly on their social media of their travels and lavish expenditures.
Lifestyles which appears to be incongruent with the amount of declared income can expect to be audited.
Using your Vehicle for business / Claiming vehicle expenses
Vehicle expenses are often arbitrarily determined. When preparing their tax return, often times taxpayers and their accountants pick a reasonable number for vehicle expenses based on an estimate of the percentage of the vehicle usage used for business purposes.
Few taxpayers actually keep a log of every trip, yet every one should!
Not having a log, and corresponding calendar means that few taxpayers can prove to the CRA with absolute certainty, the use of a vehicle for business purposes – thus making it easy for the CRA to deny the expenses.
Real estate transaction
Thank you Liberal government and your out of control spending.
As a result of the need for tax revenue to pay down the debt and deficit, the CRA began cracking down on real estate transactions in the past 5-years. Had the Liberals won a majority government in the 2019 Federal election, there would be capital gains taxes on the sale of principal residences. Right now, it is a requirement for Canadians to track and list on their tax returns the sale of their principal residence.
To say that the CRA pays careful attention to real estate transactions would be an understatement. The CRA frequently audits HST rebates, pre-sale condo flips, new home construction, principal residence exemptions, and many other real estate transactions.
Being involved in multiple real estate transactions sharply increases the chance of being audited.
Home office expenses
The CRA loves auditing home office expenses. Home office expenses are often arbitrary and over-declared, along with the percentage of time the home office is actually used, and the percentage of the house used for the purpose of earning income.
Operating a cash business
When there is a lot of cash being received by a merchant, there is more opportunity for the CRA to recover taxes on undeclared cash income. One common trick the CRA will perform involves the deposits going into the business or personal bank account which are significant, repetitive or unsupported. In these instances, they are declared as income, and a 50% gross negligence penalty is applied.
Adjustments / Amending returns
The CRA is on top of the business or taxpayer who declares a little income and then amends their returns after the fact to report the actual, and much higher balance. Not only is the prohibited, but it’s a great way to be audited.
If the amending results in a refund, or a refund is issued and then the correct filing results in a balance outstanding, then – you can expect an audit.
Donations – Large and Tax Shelters
If charitable contributions are suspiciously large and do not seem to be possible or likely within the confines of a taxpayer’s income, such donations or contributions are very likely to be audited.
As well, charitable contributions made to organizations suspected of being involved in tax schemes are even more likely to be subjected to an audit.
As long as there are taxes there will be individuals and organizations selling (and conning) taxpayers into participating in tax schemes to reduce taxes. Some of these schemes are outright frauds, while others have no fraudulent intent, but for one reason or another fail.
The Canada Revenue Agency actively and aggressively audits taxpayers who are involved in a tax shelter, a gifting program, or any other tax scheme.
In many circumstances, taxpayers are able to receive refunds and benefits from these programs for several years prior to the CRA auditing, and then reassessing the donation. Unfortunately, since it can take a bit for the CRA to learn of the scheme, and refunds are issued / debts reduced, the participants often bring in family and friends and get them caught up in the program.
Typically, in these schemes, taxpayer may receive tens or hundreds of thousands of dollars of CRA refunds to which they were never entitled only to have the CRA come back and audit and reassess years later, along with gross negligence penalties and interest. $100,000 in illegitimate refunds can turn into more than $200,000 once penalties and interest and the passage of time have been taken into consideration.
The rule of thumb is that if it appears too good to be true, it is.
Shareholder loans which are not repaid within a year after the year-end of the corporation are often audited, because the CRA suspects they are not legitimate and were simply paper transactions.
Loans where shareholders took revolving loans from the corporation, paying each off just prior to the deadline and then taking a new loan, are also on the CRA’s radar for audit due to their tax benefits.
It shouldn’t need to be said, but taxpayers who are both shareholders and employees of the corporation should be very careful with shareholder home loans, and should have all supporting documentation available.
In order for a home loan to be treated as an employee home loan rather than a shareholder loan, the loan must be made because the person is an employee, rather than because they are a shareholder and should be available to all other employees.
The CRA regularly conducts mini-audits to ensure that parents who claim childcare expenses maintain proper documentation, and that the children actually attend the establishment for child care and not just for playdates. Claiming childcare for children who hang out with their grandparents a few days a week while the parents are not both working out of the home, would prompt an audit.
Employees who are issued a T2200 form by their employer are entitled to deduct certain employment expenses from their income. Perhaps the employee has to pay for their own vehicle to travel to sales calls, or perhaps they have to maintain a home office. As long as the employer requires that the employee pays these expenses in respect of their job, they likely can be deducted from income.
Since this is an abused area (each expense is paid for with pre-tax dollars and reduces the overall tax paid by the taxpayer) the CRA audits many employees with the T2200 to ensure that a) their form is properly completed and may be used to deduct the expenses in question and b) each of the expenses claimed was legitimate and for the purposes of their employment, as outlined in the T2200.
If the CRA keeps coming back and auditing and re-auditing every aspect of a business – and if they keep finding issues – that business or taxpayer can expect to be on the audit list for each and every year.
All business profits are subject to taxes. This includes both legitimate and illegal businesses. As far as the CRA is concerned, if you are earning income you should pay taxes. Period.
So if a taxpayer is accused of or convicted of a crime and the CRA learns about the illegal business which was taking place, they often audit and reassess the taxpayer for taxes on the proceeds of crime – whether or not the taxpayer still has such proceeds. Often times, criminal activity is weeded out during an audit, as opposed to the CRA knowing there is an illegal business and pretending that it is legitimate.
These audits usually require the supporting documentation to justify expenses, and often there are none provided resulting in extremely large assessments.
Keep your records together by year, and expect to be audited each and every year. When you are not, be thankful.